This article has been written by Sagar Narendrakumar Surana pursuing an Executive Certificate Course in Corporate Governance for Directors and CXOs from Skill Arbitrage.

This article has been edited and published by Shashwat Kaushik.

Introduction 

Independent directors are the essential elements of good governance, having an impartial view that works in favour of shareholders’ and stakeholders’ interests. They are not the same as the management from the inside of the organisation. They are observers on the board and take part in strategic and ethical management. However, their role is not just about regulatory compliance; it also helps to enhance the board’s effectiveness as well as accountability. The integration of those in India strives to improve good governance, which is the principle of bringing transparency and fairness to corporate administration. This compliance with international standards promotes confidence and thus spurs economic development. They are the bolsters of the values of morality and professionalism in Indian companies, thus showing India as obtaining the increasing role of the leader in the world arena.

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Historical background and evolution

The concept of independent directors, which is nowadays one of the foundations of corporate governance, has its roots in the board-level practices in Western countries, especially the U.S., first of all to fight conflicts of interest and secondly to increase the accountability of the boards of directors to their shareholders. By the end, the model that the agency follows became a global standard of shareholder protection, while the managers’ individuality came in second place.

The introduction of independent directors in Indian corporate governance was an eye-opening shift from usually dominating family or promoter controlled business firms to a more transparent, accountable and professionally managed scenario. The shift was largely initiated by the move towards liberalisation of the Indian economy in the early nineties, which led to the greater importance of the international governance standards to be followed by all investment coming into the country.

Through various legal and regulatory frameworks like the Companies Act of 2013 and the Securities and Exchange Board of India (SEBI) regulations, the approach to corporate governance practiced by Indian companies was changed by the inclusion of independent directors. These legal documents clearly defined the criteria for independence and commented on the role and responsibilities of the independent directors, which explained the need for more demanding governance in the future.
This evolution reveals an Indian social response on how to deal with both external and internal pressures, which can lead to the need for corporate accountability and transparency. This mirrors the paradigm shift from the earlier inward-looking board designs, which were composed of individuals with close ties to the management or the company promoters, towards the current equity-based approach that is not biassed towards corporate interests. This amendment is designed on the notion of lifting the quality of board decision-making and protecting minority shareholders for the purpose of enhancing the confidence of the general public in Indian businesses both nationally and internationally.

Rise in demand for independent directors

Businesses in India are under pressure to renew their boards by the 2024 deadline for the ten years of the term limit, which has resulted in a rising demand for independent directors. This pattern of events, however, is not restricted to achieving compliance but also reflects a much clearer perception of the duties of the independent directors in an organisation.

Key drivers:

  • Regulatory reforms: SEBI and the Companies Act of 2013 have made a small number of independent directors mandatory for listed companies. This policy has been directly supporting the demand for independent directors.
  • Global standards: With the growth in businesses of Indian companies globally, the need for grid alignment of them with global governance norms is increasing and there is a call to appoint independent directors from abroad.
  • Business complexity: The business environment, which is continuously evolving and changing, requires the strategic advice received from independent directors, to overcome the challenges.
  • Investor confidence: Independent directors are today widely perceived as indicators of good governance that have a convincing influence on investors’ decisions.

The transformation where independent directors are perceived merely as formalities to their vital importance as one moves away from the old corporate governance paradigm to a new paradigm that stresses transparency, accountability, and strategic guidance is a significant one in the Indian corporate governance landscape.

Roles and responsibilities

These days, independent directors are a powerful tool in corporate governance because they do not only fulfil the formal requirements. They are so crucial in terms of strategic management, as they provide a wide-ranging outlook for the development of business policies and strategies. With an unbiased perspective on hard problems such as the CEO and corporate performance review, one can see the trend of being pro-stakeholder.
This includes the risk management abilities of the candidates, which include financial, operational and reputational risk identification and mitigation. In the area of corporate governance and ethics, they ensure that they are in compliance with the laws and regulations, that governance is followed, and that entities are held accountable.

They do an audit of the audit committee that is responsible for supervising financial reporting and auditing functions to ensure that transparency and accuracy dominate the reports, which are important in bringing investors closer to the company. Furthermore, they perform the functions of an intermediary and a lobbyist for the company, defending the interests of shareholders and emanating the middle position between them, thus developing the social responsibility and reputation of the company.
This kind of expansive role once again attests to the importance of independent directors in this era of complex business, maintaining the sustainable success and moral standing of companies.

Challenges and limitations

The complications and limitations that Indian independent directors face are multi-faceted due to their origins in the intricate nature of the issue and the extreme complexities of the Indian corporate governance structure. One of the significant pitfalls is the unmodified adoption of the concept of the independent director stage from the western corporate governance frameworks, which might need some refashioning to fit the national culture. They risk being under less pressure by going non – local which can cause them to fail to match the standard set before them or to be incompatible with performing the task given to them. We need to note that family owned and promoter driven businesses are more obvious in India but this can lead to their potential practical implementation being “affected.”

The other major issue is the conflict of interest that might arise since some independent directors may have existing or past relationships with the company management or key stakeholders. The board directors could already be biassed; they could be making underlining decisions and they tend to act in favour of some shareholders.

To solve these problems, India needs corporate governance for everyday use. The above could comprise the calibrating process of non-executive directors, taking into account the local industry context. The government will not be eluded by the obstacles that may hold it down. The regulation can be improved to make sure that the appointment is done with transparency and accountability. Independent directors can be put in place to prevent the risks.

The independent directors’ role in corporate governance in India can be dramatically improved with this medication and the repair of these gut abnormalities, which consequently will make the corporate governance process more robust and transparent.

Regulatory framework and legal aspects

The Indian legal and regulatory framework relating to the object of appointment of the independent directors was continuously amended with the intention of ensuring more transparency and enhancing their effectiveness. In India, the Securities and Exchange Board of India (SEBI) took up this duty.

In February 2023, SEBI directed some changes in the LODR regulation aimed at the ultimate transparency provided by listed entity disclosures. The amendments regarding accepting the movement of any information exchange or release as material if a quantitative threshold is necessary and for top listed firms to confirm, deny, or clarify market gossip. However, SEBI also wants to have some amendments so that this topic of unpublished price-sensitive information will be more clear to understand and there is unification for these companies.

Moreover, the Capital Market Regulatory Authority has revised the Guidelines on Independent Directors. The shareholders have the right to approve the latest person who was appointed to the board either at the next meeting or three months after his appointment. The reappointment of independent directors together with the special resolution will also be included, while the entire case of vacant positions will be filled within three months. This is what is meant by the amendments, which are aimed at resolving the practical issues in the process of appointing the directors and ensuring that the process is transparent and there is shareholder participation.

In addition, the proposal suggests that a mandatory separation period of three years be imposed for those directors who hold financial interests in the listed entity or its related parties to act as independent directors. The following constitutes a plan for directors, including officials and employees from Promoter Group and their relatives, with the definition of independence for directors. The dual vote system selection and reappointment, which is independent director appointment by a shareholder holding the minority position, and the extent of making the candidates as independent directors independent through this dual vote system.

The corporate reforms show SEBI’s commitment to the implementation of an independent director system in the Indian corporate sector, which, in turn, offers protection of the interests of all stakeholders.

Case studies and empirical evidence

The independent directors’ case studies on the Indian corporate governance system will prove its effectiveness, as will the case of Tata Group. The Tata Nano incident took place during Cyrus Mistry’s tenure and, therefore, shows the complexity and all of the problems and challenges that corporate boards have to deal with and how important the role of independent directors can be in the resolution of the problems.

Tata Nano, a “People’s Car,” made Tatan Tata want to develop a new mode of communication that will be safe and affordable for an Indian family. At first initiated with the purest of intentions, the project faced many obstacles, including land acquisition protests in Singur, West Bengal, which further caused a shift to Sanand, Gujarat, price and operational issues at time and an unpredicted decline in sales.

It can be extrapolated from the offerings of Tata Motors and Nano Project that the prospect of having independent directors is highlighted because they contribute the most to giving unbiased supervision and strategic insight, especially when emotions and historical legacy are guiding management’s decisions. Besides the independent directors, the difficult decisions are sometimes beyond them after all, such as stranding less-profitable ventures like the Nano, which is very important to the company’s leadership.

Furthermore, the board and the management’s influence on the independent directors’ shares in India makes a difference in their effectiveness in carrying out their duties since their role is hampered. In a way to give them greater independence, it has been suggested that, for example, a national level of an independent directors’ supervisory board could be designed. This would operate separately from the company’s board, thus maintaining the power balance in the system. This will be the board that determines those who will serve on it hence, it has the potential to fix some of the weaknesses where the remuneration and nomination committees that are appointed by the board would not necessarily ensure the directors independence.

The occurrence of these examples gives an insight into the pivotal role that independent directors play in corporate governance, highlighting the importance of proposed reforms that will build their independence and effectiveness in handling complex corporate situations.

The future landscape and recommendations:

It is expected that in the coming years, the future of independent directorship in India will be in line with global governance norms targeting a more transparent, diverse and accountable way. To improve the effectiveness of independent directors, we can follow the below points:

  • Enhanced selection: Implement rigorous and public selection methods, maybe by involving the third party, to guarantee the director`s professionalism and neutrality.
  • Board diversity: Consider board diversity in composition involving the issues of gender, expertise, and cultural background to contribute different perspectives into the decision-making process.
  • Focused training: Conduct a solid training programme on their roles, mandates, and current governance trends for the independent directors.
  • Performance evaluation: Introduce independent director structured performance evaluations, involving peer evaluations and external reviews to ensure board members accountability.
  • Updated regulations: Developing clear regulations that define freedom and requiring conflict-of-interest disclosures to safeguard the separation of directorships can improve independence.
  • Digital competency: Engage private directors to be abreast of digital trends and risks as well, which are fundamental standards in modern corporate governance.

This way of approaching the task is aimed at strengthening the role of the independent directors, who can guide the companies through complex governance spheres and to do that, these directors elevate the confidence of the investors and corporate integrity.

Effectiveness of independent directors

  1. Enhanced corporate governance:
    • The presence of independent directors has significantly strengthened corporate governance practices in India, fostering a culture of transparency, accountability, and ethical decision-making.
    • Independent directors bring an objective perspective to the boardroom, challenging management decisions and ensuring the protection of minority shareholder interests.
    • Their contributions have led to improved board effectiveness, enhanced risk management practices, and greater compliance with regulatory requirements.
  2. Improved financial performance:
    • Empirical studies have consistently demonstrated a positive correlation between the presence of independent directors and improved financial performance.
    • Independent directors contribute diverse skills, knowledge, and experience to the board, which enhances the strategic decision-making process and mitigates agency problems.
    • They also provide valuable oversight of the company’s financial reporting and internal control systems, reducing the risk of financial misconduct and enhancing investor confidence.
  3. Increased investor confidence:
    • The presence of independent directors is a key factor in building investor confidence, both domestic and foreign.
    • Investors perceive companies with a strong independent board structure as being more transparent, accountable, and trustworthy.
    • This perception leads to increased investment and a higher valuation for the company, as investors are more willing to commit their capital to companies with effective corporate governance practices.
  4. Mitigating agency problems:
    • Independent directors play a critical role in mitigating agency problems between managers and shareholders.
    • They ensure that management decisions are aligned with the long-term interests of the company and its shareholders, rather than the short-term interests of management.
    • Independent directors also provide oversight of executive compensation and monitor management performance, ensuring that managers are held accountable for their actions and that their compensation is appropriate.
  5. Promoting sustainable business practices:
    • In recent years, independent directors have increasingly focused on promoting sustainable business practices and environmental, social, and governance (ESG) initiatives.
    • They recognise that long-term corporate success is inextricably linked to sustainability and responsible business conduct.
    • Independent directors can drive the adoption of sustainable practices, such as reducing carbon emissions, enhancing supply chain transparency, and promoting diversity and inclusion, by providing strategic guidance and oversight.
  6. Challenges and opportunities:
    • Despite the significant progress made, there are still challenges to the effectiveness of independent directors.
    • These include ensuring true independence, addressing potential conflicts of interest, and enhancing the diversity of independent boards.
    • Opportunities for independent directors lie in leveraging technology to improve boardroom communication and decision-making, collaborating with stakeholders to drive positive change, and continuously enhancing their skills and knowledge to stay relevant in a rapidly changing business landscape.

Despite the progress made, there are still areas where the effectiveness of independent directors can be further enhanced. For example, there is a need to ensure that independent directors possess the necessary skills and expertise to contribute meaningfully to board discussions. Additionally, the independence of directors can be further strengthened by reducing the influence of promoters and dominant shareholders.

Conclusion

At this point, we couldn’t agree more that the voice of independent directors in leading the standards of corporate governance is undoubtedly important in our country. It is in the form of a chain that consists of transparency, accountability and ethical business practices. They are impartial, and their rational reasoning and intelligent opinion are really helpful when taking decisions. Taking into account the opinions of all the parties in the relationship (the shareholders, the employees, and the customers), they allow them to integrate into the process, considering the needs of all the parties in the relationship. Establishing and adhering strictly to those codes of ethics and conduct, independent directors will be the ones who hold the mirror and work as beacons, directing organisations to the path of sustainable growth and profitability. They eradicate the speculations in the minds of the investors and make the integrity of the Indian business sector shine on the world order. As corporate structures keep evolving, the relative efficiency and empowerment of independent directors will remain essential in guiding the companies through the intricacies of the modern business environment and ensuring that the companies not only exist but also thrive in a world that is very competitive and monitored.

References

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